Christopher Schwarz

Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a sample of 444 due diligence (DD) reports from a major hedge fund DD firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%). Misrepresentation, the failure to use a major auditing firm, and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk. We find that DD reports are typically performed after positive performance and investor inflows. We control for potential bias due to this and other potential conditioning. An ...

Published: Brown, Stephen & Goetzmann, William & Liang, Bing & Schwarz, Christopher, 2012. "Trust and delegation," Journal of Financial Economics, Elsevier, vol. 103(2), pages 221-234. citation courtesy of